What's behind this week's market turmoil?

9 February 2018, 15:53

This looks like being the worst week for stock markets since 2011.

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Following the second violent sell-off on Wall Street this week, which took the S&P; 500 index and the Dow Jones Industrial Average into "correction" territory for the first time in more than two years, there were big falls on Asian markets.

The Shanghai Composite in China suffered a 6% drop at one stage and, having fallen by 10% since the beginning of the month, now languishes at levels last seen in May last year.

The Nikkei 225 in Japan meanwhile, has finished this week some 8% lower than it began it, the biggest weekly fall for two years.

Hong Kong's Hang Seng is down 9.5% on the week, its worst weekly fall for more than a decade.

In Europe, while Friday's falls have not been as severe as those seen overnight in Asia and on Thursday night on Wall Street, there have nonetheless been further setbacks.

The FTSE-100, the CAC 40 in France and the DAX in Germany all look like finishing between 4-5% lower on the week.

On Wall Street, meanwhile, things have opened on a firmer footing for now.

While the declines on stock markets are by far the most eye-catching, it is also worth noticing that other so-called "risk assets" have also fallen.

The price of a barrel of Brent crude is down by just over 6% on the week.

On currency markets, as investors have moved into safe havens like the US dollar and the Swiss franc, other currencies have suffered.

The Australian and New Zealand dollars have fallen against their US equivalent, central and eastern European currencies like the Polish zloty and the Hungarian forint have fallen against the euro, while the pound is lower against both the US dollar and the euro even after the rally on Thursday sparked by the Bank of England's warning that interest rates are likely to rise more rapidly than expected.

On bond markets, meanwhile, yields - which rise as the price falls and fall as it rises - have also attracted buyers looking for safety.

Japanese government bonds (JGBs) and German bunds have all attracted buying in the last 24 hours following the sell-offs on equity markets.

So what's going on? Well, it's a combination of factors, but undoubtedly the most important is that, ever since Donald Trump was elected President, Wall Street has been on a tear.

All of the major US indices broke record after record during 2017 with the Dow, for example, hitting a closing high on an unprecedented 71 occasions.

The S&P500;, the most meaningful US stock index, went through the entire year without falling by 3% or more in one session - something that had only happened once in its 94-year history.

It rose by just under 20% during the year, a performance bettered on only 13 occasions.

Moreover, notwithstanding a few tremors, the US and European stock markets have been rising solidly since 2009, making this one of the longest bull runs in history.

All good things come to an end at some point and, with stock prices increasingly becoming out of kilter with expected company earnings, some kind of correction was inevitable.

That was particularly the case given the unusual lack of volatility seen in markets during 2017.

When volatility reasserted itself, that was always going to lead to some violent sell-offs, particularly in view of the fact that interest rates have been at close to zero in most advanced economies for the best part of a decade, meaning some investors have been moving in to riskier assets in search of yield.

Now that central banks everywhere - most notably the US Federal Reserve, but also the Bank of England - are starting to raise interest rates again and are signalling that the asset purchases (quantitative easing, or QE, in the jargon) put in place as an emergency measure after the financial crisis are coming to an end, some may start to favour cash again as an investment.

That previous lack of volatility appears to have been one trigger for the recent turbulence.

A number of trading strategies of late have involved selling the VIX index, sometimes known as Wall Street's fear gauge, which meant that, as volatility increased, traders had to "de-risk" themselves by selling shares.

That simply added to a sell-off sparked last Friday by figures pointing to stronger-than-expected US wages growth - which rekindled fears about a pick-up in inflation and the possibility that the Fed would need to raise interest rates more rapidly than expected.

The third contributory factor, as highlighted before, has been a downturn in the lack of human beings working in markets.

There are fewer market-makers - the traders who stand ready to buy and sell any security and who grease the wheels of stock markets - and there is more automated trading.

One machine is likely to do the same as another when confronted with the same conditions whereas a human trader is likely more quickly, for example, to conclude that a stock has been over-sold and to start buying speculatively.

How should investors react? Firstly, and obviously, by not panicking.

Anyone selling into a downturn risks worsening their losses by selling at too low a price.

For people investing for their retirement, via ISAs and pensions, the stock market should be a long-term game.

Terry Smith, one of the UK's cleverest and most successful fund managers, has always set his face against trying to "time" the market by trying to establish what is the best time to buy or sell.

But the other thing investors should do is brace themselves for more volatility.

The era of cheap money is over and the world is moving into an environment in which the Fed, the Bank of England and, in time, the European Central Bank and Bank of Japan, are raising interest rates and unwinding QE.

That should be welcome, as it means the world economy is returning to more normal conditions after an extraordinary period of ultra-cheap money - which was a boon for the stock market - but it means there are likely to be more sharp sell-offs and, potentially, less spectacular returns than those enjoyed in recent years.

So, unless you make a living from punting and short-term speculation, don't panic.

The stock market is a long-term game and, as has been shown many times, one for the patient.